Previously published by JennieXue.com, as a part of public education
The 2008 recession, commonly known as the Great Recession or the Global Financial Crisis, was a severe economic slump that started in late 2007 and lasted until 2009. It was the most significant financial crisis since the 1930s Great Depression and had a long-term effect on the global economy. Let’s use it as a case study in our journey to understand the big picture of the global economy and how to recognize economic indicators for our own use.
What Occurred in 2008?
The American housing market was at the heart of the 2008 recession. Before the crisis, there was a housing bubble driven by cheap interest rates, loose lending regulations, and a flood of subprime mortgages.
Financial institutions packaged these subprime mortgages into mortgage-backed securities (MBS) and collateralized debt obligations (CDOs), then marketed them to investors worldwide. Many people assumed that the property market was invincible as prices increased.
Nevertheless, when interest rates began to increase, and property prices began to fall, many homeowners defaulted on their loans, leading MBS and CDO values to drop. This failed numerous large financial organizations, including Lehman Brothers, which had significantly invested in these products.
The crisis expanded fast across the global financial system, causing a credit shortage, decreased consumer spending, and massive job losses.
What We Can Learn From the 2008 Recession
The 2008 financial crisis highlighted significant flaws in the financial system and regulatory environment. Among the important lessons learned from the crisis are the following:
The significance of financial regulation and supervision: The crisis revealed the need for tighter restrictions to protect financial firms from taking excessive risks.
The crisis demonstrated how troubles in one country or industry might swiftly spread to other nations or sectors, emphasizing the significance of international collaboration in dealing with financial crises.
The role of central banks: Central banks, like the US Federal Reserve, were critical in stabilizing financial markets and preventing the global economy from collapsing completely. Their actions emphasized the significance of central banks as lenders of last resort and their role in preserving financial stability.
The necessity for effective government intervention: The crisis prompted a slew of government bailouts and stimulus packages to recover the economy. These efforts underscored the significance of early and focused government responses to financial crises.
What Makes Today Unique
Many improvements have been taken after the 2008 recession to strengthen the global financial system:
Improved financial rules: The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in the United States to enhance financial regulations, promote transparency, and prohibit financial firms from taking excessive risks.
Stricter capital requirements: Banks must keep more capital to absorb losses and withstand financial shocks. In reaction to the crisis, the Basel III framework considerably boosted capital requirements for banks globally.
Stress testing: Financial institutions are now subjected to frequent stress tests to determine their capacity to deal with catastrophic economic situations. These tests guarantee that banks have sufficient capital to weather possible crises.
Risk management has been improved: The crisis has emphasized the significance of solid risk management processes inside financial institutions. Since then, there has been a greater emphasis on enhancing risk management systems and guaranteeing their integration with bank operations.
Although the global financial system has grown more robust since the 2008 financial crisis, it is critical to stay watchful and proactive in detecting and mitigating possible risks. This will assist in averting future crises and guarantee the global economy’s long-term stability.
Understanding Key Economic Indicators
What indications should we look for to comprehend the status of the economy, at least from our own (subjective) perspective? Monitoring important economic indicators might help identify a sagging economy, sometimes an economic downturn or recession.
Several of these indications are listed below, along with examples and references:
GDP fall: A decline in GDP for two or more consecutive quarters implies that the economy is declining. For example, the US GDP fell for four consecutive quarters during the Great Recession (2007-2009) (Source: US Bureau of Economic Analysis).
High unemployment rate: Growing unemployment is another symptom of a deteriorating economy, as businesses lay off workers and demand for products and services falls. During the COVID-19 pandemic, the US unemployment rate peaked at 14.7 per cent in April 2020. Today in April 2023, it’s at an all-time low at slightly above 3 per cent (Source: US Bureau of Labor Statistics).
Consumer expenditure reduction: A decline in consumer spending indicates that consumers are reducing their purchases, frequently owing to worries about job security or income. Personal consumption expenditures (PCE) in the United States fell by 12.6 per cent in April 2020, the worst reduction on record (Source: US Bureau of Economic Analysis).
Low inflation or deflation: When the economy is in a downturn, demand for goods and services diminishes, resulting in lower prices (deflation) or stagnant prices (low inflation). During the “Lost Decade” in the 1990s, Japan faced chronic deflation (Source: Bank of Japan).
Decreased industrial output: Lower commodity demand often decreases industrial production as firms reduce manufacturing. The US industrial output index fell 12.5 per cent in April 2020, the most significant loss since records started in 1919. (Source: Federal Reserve).
Low business confidence: The amount of optimism among company owners and managers about the future of their enterprises is measured by business confidence. A standard business confidence index suggests a bleak economic future. In Germany, for example, the Ifo Business Climate Index fell to 74.3 in April 2020, the lowest level since the 2008 financial crisis (Source: Ifo Institute).
Decreased investment: When firms and people become more concerned about the future, a collapsing economy may lead to reduced levels of investment. In the second quarter of 2020, gross private domestic investment in the United States declined by 27.2%. (Source: US Bureau of Economic Analysis).
Falling stock market indices: A drop in critical index like the S&P 500 or Dow Jones Industrial Average might indicate a loss of confidence in the economy’s prospects. In March 2020, the S&P 500 saw its quickest decline into a bear market in history, shedding 34% of its value in just over a month (Source: S&P Dow Jones Indices).
Inversion of the yield curve: An inverted yield curve happens when long-term interest rates fall below short-term interest rates. This condition often precedes a recession. Before the COVID-19-induced downturn, the US Treasury yield curve inverted in August 2019. (Source: US Department of the Treasury).
Increasing government debt: When the economy is in a downturn, governments may raise their debt to pay stimulus measures or to compensate for lost tax income. Due to the pandemic and subsequent relief operations, the United States government debt soared dramatically in 2020. (Source: United States Department of the Treasury).
The above indicators depict a complete image of whether an economy is healthy, helping government officials, corporation executives, and lay people make educated choices in response to economic issues. Understanding the key economic indicators helps us become better analysts who can make objective financial judgements, such as whether to buy houses and when to slow down or increase our other material and immaterial assets.
Finally, being a strong financial and economic analyst will make you a better philosopher. What doesn’t kill you makes you stronger.
Previously published by JennieXue.com, as a part of public education